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Will mandatory CEO rotation for banks achieve better governance?

Adding a layer of tenure-based caps will not incrementally strengthen governance standards for Indian banks. Instead, RBI already has powers for approving CEO reappointments. It must use these.

June 18, 2020 / 11:01 AM IST

The appropriateness of ‘CEO tenure’ is debated in the context of good governance practices, but there is no consensus on this issue: it is impossible to know ex-ante who will be a good leader, and who will be great. The Reserve Bank of India’s (RBI) discussion paper on governance in commercial banks suggests a cap of 10 years on promoters as CEOs with no possibility of return. For professional CEOs, the tenure is being capped at 15 years, with a possibility to return after a three-year cooling-off period. Of the listed banks, Kotak Mahindra Bank and AU Small Finance Bank will be immediately impacted by this provision. There will not be any incremental impact on HDFC Bank, since Aditya Puri is scheduled to retire in 2020. In another six years, five more banks will be compelled to rotate their CEOs.

It is unclear why an entrepreneur, who will have more skin in the game — and whom RBI has given a banking licence to — needs to have a shorter tenure, while professional CEOs are given a longer rope. Surely this cannot be a simplistic conclusion drawn from the governance failures of a few private sector banks, the most recent being Yes Bank. (Yes Bank is one of IiAS several shareholders.)

The arguments supporting the mandatory rotation are many. Periodic rotation allows for fresh thinking and new skills in a changing environment. New leadership will also necessitate better transparency. And, if the tenure is reasonably long – as has been prescribed by the RBI – there is a balance between short-termism and thinking for the long-term. An expected end to the tenure allows for planned succession, compels boards to think about a smooth transition and build a strong second line of management. The need for institutionalisation of a bank becomes that much greater. Mandatory rotation is considered more seriously when the roles are fiduciary in nature – therefore, regulations recommend rotation of auditors and independent directors. Bank CEOs are a natural corollary. The Securities and Exchange Board of India (SEBI) too has mandated tenures for the CEOs of stock exchanges and depositories.

On the other hand, the performance of public sector banks (PSBs) is testimony to the fact that CMD rotation has not worked. One could argue that CEO rotation in PSBs has been much too soon, with almost all CEOs holding their term for less than five years. Therefore, the RBI needs to set a minimum tenure criterion for CEOs of public sector banks while prescribing term limits for the private banks. The 2014 PJ Nayak Committee was silent on the CEO tenure, yet recommended a minimum tenure of five years for a bank’s chairperson (the role was to be separated from that of the CEO) and a minimum tenure of three years for executive directors. Perhaps CEOs of PSBs should have a minimum tenure of five years, too.

Past CEOs of corporate India, having been at the helm over decades, had become almost untouchable; their long-standing tenure was largely because they created massive shareholder wealth. Shareholders found it difficult to displace these power centres, with the fear that the larger-than-life CEO was the only critical driver of the company’s continued success — part of the fear being driven by the lack of succession planning. As successors were brought in, the market forces realigned themselves quickly enough to accept the new leadership as the new normal. And it will be true for the banking sector as well.

Close

In setting a cap to the absolute tenure, the RBI is signalling the need to institutionalise banks and prepare for succession. Yet, the central question is – just for a checkbox cap of tenure, should CEOs of well-run banks be asked to vacate their positions? One argument is that the bank’s primary stakeholders are the depositors and the borrowers. Since they do not have a say in the CEO’s reappointment, capping the tenure is an optimal solution.

The Institutional Investor Advisory Services (IiAS) argues that the RBI has the power to curtail CEO appointments, since every reappointment requires RBI approval. As the central bank conducts regular audits of banks, it is also better placed to understand a bank’s practices. The RBI curtailed the tenures of Rana Kapoor and Shikha Sharma in the recent past; it can surely exercise its existing powers for others when required.

The PJ Nayak Committee too did not recommend capping the CEO tenure: instead, it suggested that where the principal shareholder in an entrepreneur-led bank is also the bank's CEO, the RBI should satisfy itself that the board is adequately diversified and independent. Where the banking regulator is not confident about such independence, the controlling shareholder should be asked to step down as CEO. The same applies for professionals who are CEOs.

The CEOs of listed private sector banks have an additional layer of scrutiny:  shareholder approval is required for them to hold on to their seats. With promoter voting rights of private sector banks capped at 26 percent, promoters cannot use their shareholding to stay in the driver’s seat. The rules for public sector banks, which account for 62 percent of banking assets, are different. CEOs of listed PSBs are appointed by the Government of India (GoI) and do not require shareholder approval. Even if they did require shareholder approval, the GoI can ensure the CEO’s tenure by voting its entire shareholding – GoI’s voting rights in PSBs are not capped.

IiAS believes that the current system of CEO appointment has sufficient checks and balances, and does not need another layer of a tenure cap. If at all the RBI wants to send a signal to banks to plan for succession, it must make this tenure cap recommendatory, not mandatory. In setting an absolute cap on CEO tenure, the regulator is shying away from using its discretionary powers and trying to find a one-size-fits-all solution to a heterogeneous set of banks.

Hetal Dalal works at Institutional Investor Advisory Services India Limited. Twitter: @hetal_dalal. Views are personal.
Hetal Dalal

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